London and major regional cities in the UK: a buy-to-let guide

Buy-to-let is the most popular form of property investment in the UK

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Investing in buy-to-let homes, or properties that are not used by owners but rented out to tenants instead, has become increasingly popular in the UK since 1996, when buy-to-let mortgages were introduced and rental enterprise became affordable to small-scale investors.

Now many potential landlords are concerned about the future of buy-to-let in the UK, with stamp duty increases, property prices getting lower and general uncertainty governing the country after the June referendum.

However, there are still good reasons to invest in buy-to-let properties:

buy-to-let mortgages are still available, and mortgage rates are not expected to increase in the short or medium term;

rental demand is getting higher, especially for micro-apartments, as more and more international students come to study in the UK;

the number of single households is on the rise;

property prices in some sub-markets (i.e. new developments in London) are starting to decrease, and now may be a good moment to enter the market while it is on the downswing.

Price movements

On average, there is an increasing price trend. Nationwide data indicate that property prices in Q3 2016 across the UK rose 5.4%, and Zoopla shows a 3.4% YoY increase in November.

The majority of the ten largest UK cities, including London, show an increase by 3–5% over the last 12 months to the beginning of November 2016 (Zoopla). London is the best-performing city, with prices having risen by more than 50% over the last ten years. It is followed by Bristol (nearly 29%) and Edinburgh (around 22%). London, Bristol and Edinburgh also offer the most expensive properties among the ten largest cities.

Despite the general increasing trend, property specialists at international broker Tranio indicate a growing amount of discounts being offered in London’s most sought-after areas. This is explained by the fact that the gap between supply and demand is narrowing, and developers are forced to lower prices in order to sell faster. In addition, decreased oil prices and general uncertainty around Brexit have driven away some groups of international buyers, including Russians and Arabs.

A Tranio client tells her story of buying a flat in Central London with a discount:

Prices can be negotiated down as much as 20%. Asking prices are also lower than before the Brexit referendum. I will give you an example in the flat on which we put an offer. The flat was listed at the beginning of this year at £1,375,000, and after Brexit the price went down to £1,100,000.

We started our negotiation at £800,000 and then raised it to £850,000; the real estate agent is probably going to meet us halfway at £875,000 (21% off the asking price). Sometimes, when they see that they cannot get good offers and all the buyers are starting low, they take the properties off the market for a while. I experienced this with two houses already. We put in an offer and they came back after a week, saying they don't want to sell. But in July, when it first happened, you could have pushed it even more. Now the pound is recovering, and there is a bit of confidence.

For buy-to-let investors, discounts mean the time is ripe. As the pound recovers and confidence returns, there is a possibility of future price growth, and the period of discounts may not extend through the next 1-2 years.

Purchase cost

Despite falling prices and, therefore, more affordable investment opportunities, many potential landlords are concerned about the increased stamp duty: as of April 2016, buyers have to pay an extra 3% stamp duty on buy-to-let purchases (rates vary from 3 to 15%). According to Gov.uk, however, six or more residential properties bought in a single transaction are considered “non-residential and mixed-use land and property” and are taxed at lower rates ranging from 0 to 5%, which is beneficial for larger-scale investors.

Other additional expenses include legal fees (0.5% of the purchase cost), survey fees, if needed (from 0.03 to 0.5%), and other costs (removal costs, service charges, etc.). Total costs of purchasing a buy-to-let property stand 7.5–8% above the purchase price. Agent fees are not paid by the investor unless a buyer’s agent’s services are used (their fees range from 0.5 to 3.5%).

High costs of purchasing a buy-to-let home may be lowered with mortgage. Investors of rental properties cannot take out a standard residential loan, but many banks and building societies offer buy-to-let mortgages. Their rates and terms are usually different from traditional property loans.

The interest rate is normally higher. The cheapest buy-to-let mortgages are available at 1.5–3.0%, and three-year fixed rates rise to 4.5–5.5%. Most buy-to-let mortgages are interest-only: this means that investors do not pay anything each month, but at the end of the mortgage term, they repay the capital in full.

The deposit is generally bigger as well. A future landlord has to put down a minimum of 25%, although sometimes (e.g. when rental income is not sufficient) lenders require 40% or more.

There are also eligibility criteria:

expected rental income: the annual rental income must be at least 125% of the annual mortgage payment (e.g. if an investor is paying £20,000 in mortgage interest a year, his rental income should be at least £25,000);

borrower’s age limits: most banks and building societies insist that the borrower must be at least 25 years old and not over 70–75 years at the end of the mortgage term;

minimum income: usually a minimum annual salary of £25,000 is required.

There can be other criteria as well. For example, buy-to-let mortgages may not be available to first-time buyers or non-residents who do not own other properties in the UK.

Returns

Buy-to-let properties in the UK’s largest cities, excluding London, offer annual rental yields of 4–8% (excluding maintenance costs). In London, the average yield is 3.7%, although in the best areas it can be as low as 2%.

For example, in Leeds the average home costs £189,172 and the average annual rental income is £13,500, so rental yield is 7.14% (13,500/189,172*100%).

If a property is bought with a mortgage, an annual return on investment (ROI) may be calculated instead of a rent-to-property price yield.

To find a yearly return on investment, the investor should subtract an annual mortgage cost from the yearly rent and work this amount out as a proportion of the investment. For a £189,172 property (an average price in Leeds), for example, that could be let for £13,500 per annum (an average rent in Leeds), an investor pays a £75,668 deposit (40%) and about a £7,000 stamp duty. The overall cost of investment is £82,668 (deposit plus buying costs), so the annual return on investment comes to 16.33% (13,500/82,668*100%).

It is worth noting, however, that taxes and maintenance costs will eat into rental return. These costs include:

apartments in Manchester: one-bedroom apartments starting from £98,000 and two-bedroom apartments starting from £140,000, with a guaranteed yield of 7% in two years.

Things to consider before buying a buy-to-let property:

Location. Location is the most important consideration, and it will likely determine the type of tenant. It is recommended to choose a promising area, a place where people would like to live for a variety of reasons (i.e. a commuter belt with good transport links, areas with good schools, or locations where new transport links or schools are expected to appear in the near future).

Tenants. Investors are advised to think about the type of tenant they want to attract: families, young professionals or students. This may help in the choice of property type and the property’s location. For example, if it is a family, the investor would consider one or two-family houses near schools. If they are students, a more appropriate choice would be small, inexpensive flats in the proximity of a university.

Condition of the property. In case of properties needing improvement, banks can restrict the amount of money the investor can borrow, and letting can be delayed. It is advisable to consider carefully whether mortgage payments would be afforded during the renovation period.

Rental income. It is worth remembering that higher yields mean higher risks. In addition, it is important to keep monthly payments below rental income to have a profitable business.